Doomed pension reform

MAY 12, 2010

By STEVEN GREENHUT

“One cannot be both a progressive and be opposed to pension reform,” argued Gov. Arnold Schwarzenegger’s top pension advisor, David Crane, during a pension-reform hearing on Monday. “The math is irrefutable that the losers from excessive and unfunded pensions are precisely the programs progressive Democrats tend to applaud. Those programs are being driven out of existence by rising pension costs.”

Yet it’s clear – from their votes and posturing during pension-related debates – that the progressive Democrats who run California’s Legislature and who controlled the committee hearing have no intention of doing anything to anger the state’s powerful public employee unions. Union leaders and activists filled the committee room to speak out against SB919, which would increase retirement ages and decrease defined pension benefits for newly hired state employees. The new levels would still be far more generous than pension plans in the private sector.

Thus I am left with this sad but reasonable conclusion: There is absolutely no chance that California’s Legislature will embrace even modest reforms to its public employee pension system, which has a pension liability that is estimated by some sources as high as $500 billion.

My conclusion is not born purely out of pessimism, even though I admit to having a generous dose of it based on my dozen years of watching public employee unions have their way with local, county and state governments. This simply is reality – one that has become more obvious after the hearing. The committee didn’t even get a quorum to take a vote. Indeed, Republican Sen. Dave Cox, R-Fair Oaks, at the end of the meeting, stated the obvious: this bill will never get out of committee and the only hope for reform is in the initiative process.

Because unions have the ability to raise political funds from member dues and have armies of foot soldiers to engage in campaign warfare, any sort of statewide initiative reform is a tough road as well. Two recent union-related initiative campaigns – a Paycheck Protection measure to reduce unions’ ability to collect dues for political purposes, and a second-tier pension reform plan – have died on the vine, as they lacked sufficient funding and signatures to make it to the ballot. The backer of the pension-reform measure has publicly accused the leading Republican for governor, Meg Whitman, of torpedoing the measure by leading on reform supporters with promises of financial aid and then dropping such support late in the game, thus leaving activists without time and resources to qualify the measure for the ballot. On the Democratic side, former Gov. Jerry Brown is seeking a comeback and has been actively courting union members and defending his ‘70s-era decision giving public employees the right to join unions. There’s not much hope that the political climate will change when a new governor takes office.

This doesn’t leave California with many options. While union activists gained the most attention with their testimony against the pension reform bill on Monday, Schwarzenegger advisor Crane gave a stunning and detailed warning about California’s pension system and about the California Public Employees’ Retirement System, the nation’s largest pension fund and a big player in the past decade’s expansion of benefits that has led to the current crisis.

Crane’s call to fellow progressives fell on deaf ears. So did his reminder of how the state’s pension system works. Union officials insist that unfunded liabilities don’t mean very much because the market goes up and down and they insist all will be well when the economy rebounds. But Crane reminded listeners that no rebound can fix the current problem. He also gave a short primer on the pension system: “When the state makes a pension promise to a state employee, it is simply promising to pay money to the employee at points in the future. Thus, state pension obligations are no different than state debt obligations, which also are promises to pay amounts in the future.  But they differ in two important respects: (1) voter approval is not required for pension obligations – governors and legislators have all the responsibility in that regard, and (2) pension costs, unlike debt service costs, are neither capped nor precisely quantifiable in advance.”

In other words, these are fixed debt obligations – no different than any other debt obligations incurred by the government, except that they are not capped and not subject to public approval. And, he emphasized, “Pension payments are senior obligations of the state to its employees and accordingly have priority over every other expenditure except Proposition 98 (i.e., K-14) expenditures and arguably even before debt service.” Prop. 98 earmarks 40 percent of the state budget to education. After that, the state must pay for these debts before it funds anything else. It’s understandable that unions take the “don’t worry, be happy” approach toward pension obligations – they get theirs no matter what. But any legislator who believes that such obligations don’t harm programs or endanger the state’s budget situation is not dealing with fiscal reality.

Crane hearing attendees that these defined-benefit pensions are funded when employers and employees make contributions to the retirement system (often, the employer, which is the government agency via the taxpayer, makes the full contribution to the system) and that the combination of contributions and investments earnings is expected to pay for the promised retirement amount. Unlike the 401(k) systems common in the private sector, however, “the state” is required to make up any shortfalls because of insufficient contributions or investment return shortfalls.

As Crane recounted, CalPERS – which testified against SB919 and insisted at the hearing that the economy was rebounding – has not been particularly accurate in its past predictions. The public assumes all the risk from this pension deal, yet “CalPERS refuses to disclose the information necessary for the state to be aware of and plan for those risks ….” In referring to CalPERS’ 1999 plan to retroactively increase pensions, Crane argued, “It’s nothing short of astonishing that the CalPERS Proposal, which promoted the largest non-voter approved debt issuance in California history, was not accompanied by disclosures of risks or conflicts of interest.  Frankly I’ve never seen anything like the CalPERS sales document, which makes even Goldman Sachs’s alleged non-disclosure look like child’s play.”

When CalPERS pitched that idea in ’99, Crane noted, it never noted that the state would be responsible for any shortfall in investment returns, that its assumed investment returns required “the Dow Jones to reach roughly 25,000 by 2009 and 28,000,0000 by 2099,” that the state had no cap on potential taxpayer liabilities, that its own employees would directly benefit from the pension increases, and that CalPERS’ board members “had received campaign contributions from beneficiaries of the legislation.”

Yet at the hearing, CalPERS had mocked the Stanford study pointing to the half-trillion-dollar pension liability, which used a “risk-free’ rate of return of 4 percent as a means to identify the current debt free from other financial assumptions. That assumption might be too low, but CalPERS’s own predictions have repeatedly erred too far in the other direction.

Union representatives insisted over and again that any pension matters should be handled at the negotiating table, even though such negotiations have resulted in the current fiscal train wreck. Unions are at their strongest at the bargaining table, especially when we considers that the government staff who supposedly represent the taxpayers also benefit from any gains the unions achieve, which in part explains such little resistance to the retroactive “3 percent at 50” deals approved in 1999 that have put California in its current bind. That formula allows public safety employees – police, fire, prison guards, etc. – to retire at age 50 with 90 percent of their final year’s pay guaranteed for their lives and the lives of their spouses. That percentage goes even high when various pension-spiking gimmicks are included.

SB919 would also rein in some of those schemes, require that the pension is based on the final three years of work and stop certain categories of workers such as milk inspectors and billboard inspectors from receiving enhanced “public safety” formulas. It’s hard to understand how anyone could oppose these reasonable tweaks given the financial data. But Senate Democrats weren’t considering serious arguments and didn’t respond to Crane’s point that “All the consequences of rising pension costs fall on the budgets for programs such as higher education, health and human services, parks and recreation and environmental protection that are junior in priority and therefore have their funding reduced whenever more money is needed to pay for pension costs.”

Apparently, there aren’t any real progressives left in California’s Legislature. The Legislature seems to be willing to take CalPERS’ word on the matter for now, even as the pension fund and its former officials have dominated the front-page news in California with wild tales of alleged pay-for-play schemes and bone-headed leveraged investments in housing developments at the height of the market.

In the union worldview, all the current problems are the result of Wall Street. The Bay Area city of Vallejo didn’t go bankrupt because nearly 80 percent of its funds went to public safety budgets that ginned up $300,000 a year compensation packages for police captains, but because of supposed municipal mismanagement. And they say there’s no need for new legislation that creates a lower, second-tier retirement plan for new hires because the system is working perfectly well.

As the Retired Public Employees Association argued in a letter to committee Chairman Lou Correa, D-Santa Ana, in opposition to SB919, “RPEA disagrees with the assertion that California’s public employee pension system is broken. California’s system of providing retirement security and healthcare for our hard working public employees has worked for years – and is working now. It is a well managed system that allows us to recruit and retain good public employees, while keeping the promise made to them for secure, fair and well earned retirement.”

There’s no question the system does work well for one group of beneficiaries. Government has been involved in a massive transfer of wealth from the private sector to the public sector and those who are slated to receive these millionaires’ pensions – often north of $100,000 a year, cost-of-living adjusted for the life of the retiree and spouse, plus full health care and other benefits, available as early as age 50 – aren’t about to give any ground even though the legislative fixes are for new hires only. The union members were so disrespectful to the few bill supporters who testified at the hearing that the sergeant-at-arms had to hush them. This isn’t about seriously dealing with a fiscal emergency, but engaging in the show-of-force politicking that public sector unions have perfected in Sacramento and elsewhere.

CalPERS own chief actuary, Ron Seeling, recently said the current pension system is unsustainable, but CalPERS officials were there telling the committee that all is well – not only with the investment fund but with its “smoothing” practices that spread debt out far into the future.

Indeed, one union official with whom I argued before the hearing just turned 50 and is eligible for a six-figure lifetime retirement benefit whenever he chooses to stop working. I’m a year younger than him and like to think that I’ve worked hard in my career also, but like most private-sector workers I see no retirement date on the horizon. We all must live with the pros and cons of the decisions we make, but from a public policy standpoint it’s odd to create a system that puts the public sector so far ahead of private-sector counterparts. More Americans are starting to see the disparity, a product of political power. One of the stated goals of the legislation, according to its author Dennis Hollingsworth, R-Murrieta, is to “put public sector workers’ compensation more in line with what is offered in the private sector.”

That’s a reasonable goal, but it’s not going to happen anytime soon – and it’s not going to be based on rational arguments. For instance, Sen. Denise Ducheny, the Chula Vista Democrat who didn’t conceal her hostility to the bill, mocked the bill because it won’t do anything to fix current budget problems (it will take years before the new savings from the new hires are realized) and because it deals only with state workers – not the many local agencies that pay equally generous packages to public employees. That would argue for a tougher bill that took on current employee benefit packages, but it’s no surprise that Ducheny was not advocating for that approach, but for the do-nothing approach of her union allies.

Some legislators are proposing some minor tweaks in pension-spiking, but the Legislature is not going to pass substantial reforms. In some cases, it is in the process of expanding retirement benefits! That means more program cuts and a continued push for massive tax increases. Democrats are pinning their hopes on plans to eliminate the two-thirds legislative vote requirement to pass budgets and on a host of fee and tax-increase proposals.

With the state punting on the issue, localities will increasingly look toward bankruptcy. In a recent Wall Street Journal column, former Los Angeles Mayor Richard Riordan and investment advisor Alexander Rubalcava argued that LA is on the brink of bankruptcy: “According to the city’s own forecasts, in the next four years annual pension and post-retirement health-care costs will increase by about $2.5 billion if no action is taken by the city government.  Even if Villaraigosa were to enact drastic pension reform today — which he shows no signs of doing — the city would only save a few hundred million per year.”

This sets the stage for a fiscal meltdown or a massive statewide initiative battle, which could rival the importance of property-tax-limiting Proposition 13 from 1978, which permanently changed California’s and the nation’s political landscape. Given the bent of the Legislature, there aren’t many other choices.